What Is A Good Retirement Budget?
Fee-for-service financial planner and founder of PlanEasy.ca
One of the most important aspects of your retirement plan is knowing how much you plan to spend during your retirement years. Knowing exactly what spending looks like in retirement is one of the most important (and sometimes the hardest to determine) parts of a retirement plan. Even small changes in spending can have a big impact on the success of a retirement plan, so making a good retirement budget is critical.
Depending on your level of spending, that last $10,000 in spending could incur marginal tax rates of 30-40%+. For example, going from $70,000 to $80,000 per year in spending will incur a high marginal tax rate on that extra spending. If we’re using RRSPs to fund part of retirement then we’d need to make pre-tax withdrawals of $14,286 to $16,667 just to support that last $10,000 in spending.
If there was no tax we could support that last $10,000 in spending with financial assets of around $250,000 (this varies from situation to situation but for simplicity we’ll assume a 4% safe withdrawal rate). But to support the taxes on those withdrawals we need much more. To support that last $10,000 in spending we need between $357,142 and $416,667 in registered assets!
This is why getting your spending assumptions right is very important when building a retirement plan.
This is where guidelines like the 70% rule can be very dangerous. It might be ok to use these rules of thumb when you’re 20-30 years away from retirement but when you’re 5-15 years away from your retirement date they can be very misleading.
To create a solid retirement plan we want to build a detailed retirement budget. We want a budget that is built from the ground up, category by category, and is based on facts. It’s more accurate to say how much you’ll spend in each category and then add it up versus using a general guideline like the 70% rule. Plus, it provides a great opportunity to review your spending and ensure it aligns with your values and goals.
There are a few key considerations when building a retirement budget.
Realistic: Grounded In Facts
A retirement budget should always be grounded in facts. It should always be shown side by side against current spending and it should be shown category by category. For example, it’s not realistic to assume a category like food/groceries will drop by 50% in retirement, but it’s hard to see these changes without having both current and retirement spending side by side.
By starting with your current spending you’ll have a retirement budget that is based on your current spending habits and is grounded in facts.
This may require a little bit of work. Some categories are easier to estimate than others. A category like property tax is easy to estimate because it’s only a few large transactions per year and simple to add up.
A category like food/groceries however can be more difficult to estimate. It might involve many hundreds of transactions and could include items from other categories.
The best way to build a retirement budget grounded in facts is to track your spending for at least a few months. But a second-best alternative is to use credit card and bank statements to estimate each spending category.
Flexible: Lots Of Discretionary Spending
Core expenses are those that are necessary for basic needs. Things like property tax and rent, food and clothing, even internet and cell phones. It’s important to understand what is core spending because there is little flexibility within those categories.
Discretionary spending however is very flexible. This could be things like travel, entertainment, gifts, donations etc. These are not critical to your basic needs (although obviously very nice to have and important for a fun and enjoyable retirement).
Retirement budgets with very little discretionary spending create more risk. There is very little flexibility if things don’t go to plan.
For example, during a major downturn like the great depression, or perhaps during high inflation like in the 70’s, it might require making short-term changes to your spending to ensure the long-term success of your retirement plan. These are extreme situations and hopefully not coming soon but they have happened before and could happen again so it’s important to be prepared.
Having a lot of discretionary spending means that short-term changes can be made to your retirement budget without impacting your core spending. We hope we never have to, but having the ability to reduce discretionary spending creates a lot of flexibility in retirement and helps make a retirement budget better (plus it provides a lot of peace of mind to have an action plan like this in place).
Robust: Includes Infrequent Expenses
Infrequent expenses are one type of spending that can catch many people off guard. These are things like vehicle upgrades, vehicle repairs, vehicle maintenance and licensing, home repairs, electronics upgrades, furniture upgrades etc etc. These are expenses that may only happen once per year or once every few years. It can be easy to accidentally leave these types of expenses out of your retirement budget.
Because they don’t happen monthly it can be very easy to forget about these expenses when creating a retirement budget (or any budget for that matter), but the reality is that these expenses can easily add 10-20% to your annual spending.
Estimating these infrequent expenses is critical to a good retirement budget. We don’t need to be perfect, but we want to be close enough on all these different types of infrequent expenses that they even out in the long run.
You might spend more on car repairs one year and then more on home repairs the next year. Over time these expenses can and do occur so it’s important to plan for them.
Ideally, infrequent expenses should be added to your retirement budget as a monthly expense. Take your annual estimate and divide by 12. This money can be placed in a high-interest savings account each month and then drawn upon when expenses arise.
This money shouldn’t be considered savings, but should be considered future spending. All we’re doing is taking an annual expense and spreading it monthly to make it easier to plan for.
Building A Good Retirement Budget
Building a good retirement budget is critical to a successful retirement. As we saw, even small differences in actual spending can require huge amounts of additional investments to support it. This is especially critical for longer retirements.
Getting your retirement budget right is one of the best ways to ensure a happy and stress free retirement.
Financial planner, personal finance geek and founder of PlanEasy.